Adjustments to Financial Statements (Cambridge International AS Accounting)
Spec point — how to calculate and record the adjustments needed and the effect on financial statements in respect of: – accruals and prepayments of income and expenses – irrecoverable debts, irrecoverable debts recovered and allowance for irrecoverable debts – depreciation – inventory valuation – correction of errors
Adjustments to financial statements
What are adjustments to financial statements?
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A trial balance is prepared at the end of the financial period
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The trial balance is used to prepare the financial statements
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However, there may be additional notes after the trial balance has been prepared
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Common items contained in additional notes are:
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Valuation of the closing inventory
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Goods taken for own use
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Damaged or stolen goods
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Goods sold on a sale or return basis
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Depreciation information for the year
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Accruals and prepayments of expenses
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Accruals and prepayments of income
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Irrecoverable debts
- Written off or recovered
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Information about the allowance for irrecoverable debts
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Errors that have been identified
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How do I make adjustments with the additional notes?
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Each additional note is used at least twice in the financial statements
- It can adjust a figure stated in the trial balance
- Or it can represent a new account that is not in the trial balance
| Statement of profit or loss | Statement of Financial Position | |
|---|---|---|
| Closing inventory | Subtract this value from the purchases | Include under current assets |
| Goods taken for own use | Subtract this value from the purchases | Add to the drawings balance |
| Goods sent on a sale or return basis | Subtract the selling price from the revenue and add the cost to the closing inventory | Subtract the selling price from the trade receivables and add the cost to the closing inventory |
| Depreciation for the year | Include the depreciation for the year as an expense | Add the year’s depreciation to the provision for depreciation which appears under non-current assets |
| Accrued expense | Add the amount to the relevant expense | Include under current liabilities labelled as other payables |
| Prepaid expense | Subtract the amount from the relevant expense | Include under current assets labelled as other receivables |
| Accrued income | Add the amount to the relevant income | Include under current assets labelled as other receivables |
| Prepaid income | Subtract the amount from the relevant income | Include under current liabilities labelled as other payables |
| Irrecoverable debts written off | Include as an expense labelled as irrecoverable debts | Subtract from the trade receivables amount |
| Recovery of debts written off | Include as other income labelled as debts recovered | Add to the bank or cash amount |
| Increase in the allowance for irrecoverable debts | Include the increase as an expense labelled as allowance for irrecoverable debts | Subtract the total allowance for irrecoverable debts from the trade receivables amount |
| Decrease in the allowance for irrecoverable debts | Include the decrease as other income labelled as reduction in allowance for irrecoverable debts | Subtract the total allowance for irrecoverable debts from the trade receivables amount |
Exam Hint If you are given a trial balance, then it can be helpful to annotate the trial balance with the adjustments before preparing the financial statements.
Worked Example Junaid provides a trial balance of his accounts at 31 December 2023.
Junaid
Trial Balance at 31 December 2023Debit
$Credit
$Revenue 116 400 Purchases 74 000 Equipment at cost 30 000 Provision for depreciation of equipment 10 800 Insurance 2 500 Rent received 5 800 Trade receivables 25 000 Allowance for irrecoverable debts 1 500 Trade payables 14 000 Bank 12 000 Inventory at 1 January 2023 18 000 Drawings 8 000 Capital at 1 January 2023 21 000 169 500 169 500 Additional information
- Inventory at 31 December 2023 was $14 000.
- Depreciation is to be charged on equipment at 20% per annum using the reducing balance method.
- Prepaid insurance at 31 December 2023 was $400.
- $300 rent was still owed to Junaid at 31 December 2023.
- Junaid had taken $500 goods for personal use. No entries were made in the ledger accounts.
- Junaid was unable to contact a credit customer, so their $1 000 was to be written off as irrecoverable debt.
- The allowance for irrecoverable debts is to be maintained at 5% of trade receivables.
(a) Prepare the statement of profit or loss for Junaid for the year ended 31 December 2023.
(b) Prepare the statement of financial position for Junaid at 31 December 2023.
Answer:
Deal with each additional item
Item 1 - closing inventory
- Subtract the closing inventory from the purchases on the statement of profit or loss
- List the closing inventory as a current asset on the statement of financial position
Item 2 - depreciation
- Calculate the net book value before charging this year’s depreciation
$30 000 - $10 800 = $19 200
- Calculate this year’s depreciation
20% × $19 200 = $3 840
- List the year’s depreciation as an expense on the statement of profit or loss
- Add the depreciation to the provision for depreciation
Item 3 - prepaid expense
- Subtract the prepayment from the insurance and list as an expense on the statement of profit or loss
- List the prepayment of an expense (other receivables) as a current asset on the statement of financial position
Item 4 - accrued income
- Add the accrual to the rent received and list as other income on the statement of profit or loss
- List the accrual of income (other receivables) as a current asset on the statement of financial position
Item 5 - goods for own use
- Subtract these goods from the purchases on the statement of profit or loss
- Add this amount to the drawings
Item 6 - irrecoverable debts
- Subtract the balance from the trade receivables
- List the irrecoverable debts as an expense on the statement of profit or loss
Item 7 - allowance for irrecoverable debts
- Calculate the allowance for irrecoverable debts at 31 December 2023
Trade receivables is $25 000 - $1 000 = $24 000
5% × $24 000 = $1 200
- Calculate the change from the previous year
$1 500 - $1 200 = $300 decrease
- List the decrease an other income on the statement of profit or loss
- Subtract the new allowance from the trade receivables on the statement of financial position
You can annotate the figures in the trial balance:
Debit
$Credit
$Revenue 116 400 Purchases
- closing inventory
- goods for own use74 000 -14 000 - 500 = 59 500 Equipment at cost 30 000 Provision for depreciation of equipment + depreciation for the year 10 800 + 3 840 = 14 640 Insurance - prepaid insurance 2 500 - 400 = 2 100 Rent received + accrued rent owed 5 800 + 300 = 6 100 Trade receivables - irrecoverable debts 25 000 - 1 000 = 24 000 Allowance for irrecoverable debts - decrease in allowance 1 500 - 300 = 1 200 Trade payables 14 000 Bank 12 000 Inventory at 1 January 2023 18 000 Drawings + goods for own use 8 000 + 500 = 8 500 Capital at 1 January 2023 21 000 Closing inventory 14 000 Depreciation 3 840 Other receivables (prepaid insurance + accrued rent) 400 + 300 = 700 Irrecoverable debts 1 000 Decrease in allowance for irrecoverable debts 300 (a)
Prepare the statement of profit or loss using the usual format
Final answer: Junaid
Final answer: Statement of Profit or Loss for the year ended 31 December 2023Final answer: $** Final answer: $ Final answer: $ Final answer: Revenue Final answer: 116 400 Final answer: Less: Cost of sales Final answer:** Opening inventory ** Final answer: 18 000 Final answer:** Purchases ** Final answer: 74 000 Final answer:** Less: Goods for own use ** Final answer: 500 Final answer: 73 500 Final answer: 91 500 Final answer:** Less: Closing inventory ** Final answer: 14 000 Final answer: 77 500 Final answer: Gross profit Final answer: 38 900 Final answer: Add: Other income Final answer: Rent received Final answer: 6 100 Final answer: Reduction in allowance for irrecoverable debts Final answer: 300 Final answer: 45 300 Final answer: Less: Expenses Final answer:** Insurance ** Final answer: 2 100 Final answer:** Irrecoverable debts ** Final answer: 1 000 Final answer:** Depreciation of equipment ** Final answer: 3 840 Final answer: 6 940 Final answer:** Profit for the year ** Final answer: 38 360 **(b) **
Prepare the statement of financial position using the usual format
Final answer: Junaid
Final answer: Statement of Financial Position at 31 December 2023Final answer:****$ Final answer: **$ Final answer: $ Final answer: Non-current assets Final answer: Cost Final answer: Accumulated depreciation Final answer: Net book value Final answer: Equipment Final answer: 30 000 Final answer: 14 640 Final answer: 15 360 Final answer: Current assets Final answer: Inventory Final answer: 14 000 Final answer: Trade receivables Final answer: 24 000 Final answer: Less: Allowance for irrecoverable debts Final answer: 1 200 Final answer: 22 800 Final answer: Other receivables Final answer: 700 Final answer: Bank Final answer: 12 000 Final answer: 49 500 Final answer: Total assets Final answer: 64 860 Final answer: Capital and liabilities Final answer: Capital Final answer: Opening capital Final answer: 21 000 Final answer: Add: Profit for the year Final answer: 38 360 Final answer: 59 360 Final answer: Less: Drawings Final answer: 8 500 Final answer: 50 860 Final answer: Current liabilities Final answer: Trade payables Final answer: 14 000 Final answer: Total capital and liabilities Final answer: 64 860
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